There are three common observations from the last few decades:

1. Total factor productivity has slowed down,
2. Interest rates have come down,
3. Broad money growth has slowed down.

For details of the former you may wish to see the recent OECD data.

For the later you may check my blog entry on ‘Broad money growth before and after 2009‘.

Now, the big question is whether these observations are related, and how.  An easy  approach would be to take the productivity slowdown as a given fact of life and based on that to prove that interest rates have to be lower in equilibrium.  This obviously leaves the productivity slowdown unexplained.

A recent NBER paper by Liu, Mian and Sufi (2019), takes a very different modelling approach based on an interesting narrative:

“Using firm-level data from the OECD, Berlingieri and Criscuolo (2017) and Andrews et al. (2016) show that the productivity gap between the 90th versus 10th percentile firms within industries has been increasing since 2000.

(…) the key point of departure is the insight that if the interest rate falls to a low enough level, then the rise in market concentration may itself constrain growth.”

from page 5 in,

LOW INTEREST RATES, MARKET POWER, AND PRODUCTIVITY GROWTH

Ernest Liu, Atif Mian, Amir Sufi

Working Paper 25505, http://www.nber.org/papers/w25505

NATIONAL BUREAU OF ECONOMIC RESEARCH,  January 2019

© 2019 by Ernest Liu, Atif Mian, and Amir Sufi

 

If there is truth in this striking and novel analysis, the fall in interest rates after the global financial crisis can theoretically be associated with the slowdown in the growth rate of productivity (and also of broad money).  But the causality this time runs from low demand and the associated low interest rates, to higher concentration, lower competition, lower innovation and thereby lower productivity growth.

These three empirical trends have been pronounced especially in Europe (after 2009) and in Japan (after 1995).  Reasons are still not so clear.

It is therefore very much worth thinking and working on this new approach and narrative further.

If the money multiplier is not a useful concept any more, how are we going to understand and model broad money growth?  In their recent paper, Frank Decker and Charles Goodhart tell us where to start:  ‘credit mechanics.’  The originators and contributors to this concept within the twentieth century are reminded in their paper:

Decker, F and C A Goodhart (2018), “Credit Mechanics – A Precursor to the Current Money Supply Debate”, CEPR Discussion Paper 13233.

My favourite part of their blog entry on this issue is:

Earlier it was based on the money multiplier, which implied that the money stock was driven primarily by changes to the central bank’s monetary base. This ignored the fact that, if the central bank wanted to fix a short-term interest rate – which it generally did – then the base had to adjust to commercial banks’ need for base money, rather than the reverse. Subsequently the divorce between the recent explosion in bank balances at the central bank and the sluggish growth in the broader money stock has scuppered the money multiplier approach. But this void is being filled by yet another partial equilibrium analysis, whereby the emphasis is focused entirely on the, supposedly unilateral, ability of the individual bank to create loans, and money, ex nihilo. In contrast, we argue that a more general approach to money supply theory involving credit mechanics and the influence of all those participating, bank debtors and creditors, both the non-bank private and the public sector, needs to be established.”

Decker, Frank and Charles A. Goodhart (2018), “Credit Mechanics – A Precursor to the Current Money Supply Debate”,  Blog entry on VOX CEPR Policy Portal, 14 Dec 2018,

https://voxeu.org/article/credit-mechanics-precursor-current-money-supply-debate

This suggested route may sound too complicated, especially for building a simple textbook model.  But unless we take it, there is no other chance of developing a really useful one.

The monetary base – such a common concept in the literature – plays no role in the determination of money supply (…)”

Borio, Claudio (2019) “On money, debt, trust and central banking,” BIS Working Papers No: 763, Bank for International Settlements, p.7, http://www.bis.org.

This recent paper of Claudio Borio, who currently is the Head of the Monetary and Economic Department of the BIS, is a must read for all students of monetary economics.

The way that monetary policy is conducted by central banks has changed fundamentally since early 1980s.  The central banks started to set the short term interest rate directly and use it as  their main policy instrument. Claudio Borio had recognized the potential implications of this structural change on monetary theory in mid 1990s:

This analysis is something any central banker responsible for implementation would find familiar. But it had not filtered through sufficiently to academia. When I first discovered it the mid 1990s, much to my disappointment I had to throw out of the window everything I had learnt in textbooks and at the university on the topic.”

Ibid, p.7.

Based on the experiences first of the Bank of Japan, and then after the global financial crisis,  of the Federal Reserve, of the Swiss National Bank and of the European Central Bank with either “large scale asset purchases” or “long term refinancing operations,” which increased free bank reserves held at the central bank and thereby the monetary base many times, with a negligible impact on the broad money stock, one cannot agree more with Borio (2019) in concluding:

(…) the money multiplier – the ratio of money to the money base – is not a useful concept.”

Ibid, p.7.

Yet I will argue in my future blog entries that explaining and modelling broad money growth via an alternative theory is possible, and would indeed be useful in macroeconomic policy analysis.